The Day The War Began

The Day The War Began

Over the last couple of days, I attended the APEC China CEO Forum, hosted in Beijing by the China Council for the Promotion of International Trade, the China Chamber of International Commerce, and the APEC China Business Council. As fate would have it, the Forum commenced the day that Trump launched his trade war against China, having opened a Northern front against Canada just a few days earlier (on Canada’s Independence Day). America is now entirely surrounded by newly-imagined trade enemies, including Mexico in the South and Europe in the East. 

As the discussions in Beijing unfolded, the contrast could not have been more extreme. As America retreats from the international stage, erects trade barriers and blames its domestic economic challenges on other countries, China continues to open up its economy, pursuing mutually beneficial international trade and development. As America incites its citizens to fight each other, China is calling for international collaboration, mutual respect and ongoing “opening up” of its own economy. As America focuses more and more on short term expediency, China’s own investments focus more and more on long-termism and sustainability.

First, some important context. I have no personal vested interest in supporting the China story per se. I travelled from New York to Beijing at my company Pottinger’s expense, motivated by a desire to continue to build our understanding of China’s perspective on the world, and its own political, economic and social motivations and objectives. Ignorance may be proverbial bliss, but it is certainly no basis for running a company (or a country, for that matter).

Ignorance may be proverbial bliss, but it is certainly no basis for running a company (or a country, for that matter). 

Second, a critical point of fact, if facts are still allowed in this age of disinformation. China’s economy will surpass the USA within the next decade. Indeed, America’s multi-front trade war may accelerate this shift. Meanwhile, many other Asian economies are growing strongly too. Year by year, the spending power of the mass affluent in Asia continues to grow. With a population of over three billion, the economic opportunities in the region will soon be ten times those in America. 

My own interest lies in where Pottinger invests its own time, energy and money. Just as America rose to become the world’s largest economy in the early twentieth century, so will China do so in the decade head. My motivation is to make sure that we – and our clients – bet on the future, rather than the past.

So, now to the meat of the discussions, from which five important themes emerged.

1. A new wave of global growth

Enormous opportunities lie ahead. As numerous speakers commented, China has successfully addressed the challenges of shortages of more or less everything that it once faced. As a result, its original focus on speed of growth is now shifting to quality of growth. This means paying much greater attention to industrial efficiency, societal fairness, and sustainability. Looking forward, this means that China’s domestic growth, as well as its investments offshore, will be driven by different motivations, creating many new opportunities for foreign businesses and international talent. 

China is thus evolving from being a world factory to being a world market, for both products and services. As we’ve written previously, China’s Belt and Road initiative provides a hard-wired rail connection from China to the Middle East, Europe and, potentially, Africa, as well as enhanced sea lanes. The initiative also provides much needed investment and expertise designed to help lift another billion people out of poverty across Asia and Africa, creating another billion consumers of products and services in the process.

China is thus evolving from being a world factory to being a world market

So long as this is done in a socially and environmentally sustainable manner – which is very much China’s objective – this will have profound benefits for those countries, as well as for China itself. In turn, this will support China’s ongoing development, supporting sustainable global growth for decades to come, creating opportunities for any country with an open approach to trade. Build walls and fight trade wars at your own peril, as you will miss this opportunity.

A new wave of global growth, driven by open borders, free trade and economic liberalism is building, this time instigated by China rather than the United States (or the UK before that). This will create a host of opportunities across a wide range of industry sectors, both inside China and across all of the countries encompassed by the Belt and Road initiative. Like any large wave, if you want to catch it, get out on the right part of the water early, and start paddling. 

2. Learn to think different, China style

The rapid industrialization and urbanization of China has had a profound impact on the quality of life for over a billion people. Over the last fifty years, life expectancy in China has increased by over 20 years, or nearly 40%. At current rates of improvement, it will catch the United States within the next decade or so. 

This development has come, however, with terrible environmental consequences. Domestically, air quality in major cities can be appalling, with pollution levels far above international standards. Globally, China is now contributing significant to carbon emissions, adding to the challenges already imposed by the level of global warming locked in by Western industrialization over the previous fifty years.

China is well aware of these challenges. Huge remedial efforts are underway, which in typically Chinese fashion don’t simply look to address the environmental challenges themselves, but also to position China at the forefront of the new industries that will emerge. As one example, China has led world investment in renewable energy technology and solar panel manufacturing for the last decade or more. As another, in two short years Byton has established itself as a serious participant in the electric vehicle race, and is scheduled to commence manufacturing in late 2019, with a vehicle priced at just Y300,000 (before any government subsidies). 

China’s approach also extends to building the consideration of sustainability into all aspects of Chinese development. In this sense, China has learned to “think different” about how best to achieve economic growth and improve social welfare. Indeed, our own experience is that China continues to study practices and results achieved in many places around the world, motivated by the desire to learn the best from the best, and evolve and apply that thinking in its own economy. 

Arguably, this is very different from the USA, a significant part of which remains bound up in the post-war economic paradigm which has emphasized short term profitability over longer term factors. Though there are large groups – including some of the world’s largest institutional investors – that are strongly focused on longer term thinking and sustainability, this approach remains the exception rather than the rule, and appears almost diametrically opposed to the strategies of the current US administration.

When they go low, we go high

At the conference, numerous speakers described Trump’s Trade War as a huge opportunity for China – a catalyst for further domestic reform, as well as a trigger for enhanced relationships with many other nations around the world. As one speaker put it: “We are focused on giving first, and receiving second”. In this context, we note that America has vacated in the global moral high ground, leaving a massive opening that China has ambitions to fill.  As one speaker commented: “We will continue to hold high the banner of globalization and multilateralism… to oppose unilateralism and trade protectionism… to ensure IP protection…”. 

No surprise then that the Chairman of Sinopec commented on Trump's trade war, to smiles and chuckles in the assembled crowd: "When they go low, we go high", a spirit rather captured by a cartoon in China Daily.

To make the most of these opportunities, it’s important to understand China’s objectives, how these will be fulfilled, and how to do business with the relevant stakeholders. On this last, a word of warning: China continues to evolve incredibly rapidly, so don’t assume that what worked five years ago is still relevant today. 

3. It’s The Long Term, Stupid!

An admission: I’m so obsessed with the importance of long term thinking as the only way to approach complex decisions in an increasingly short-term world that I wrote a book on the subject, The Long Term Starts Tomorrow.  Having lived and worked in dozens of countries around the world, in good economic times and bad, two truths are abundantly clear. Introspection and a belief that you have all the answers is a sure-fire way increase risk in your business. Ignoring the long term is like driving blindfold down a motorway: certain to end in disaster.

As you think about the long-term certainties of Chinese economic development, it’s critical to remember that the country is still at a very early stage of its own development, despite the extraordinary achievements of the last 50 years. GDP per head is still just c. US$8,600, just one seventh of the USA. Though it is close to becoming the world’s largest economy, it still ranks just 71st in terms of nominal GDP per head, compared to 7th for the USA, implying substantial growth lies ahead.

China’s investment to support global growth will support ongoing wealth creation in its own economy, including the emergence of the world’s largest middle class, over the next couple of decades. As this plays out, Chinese domestic demand for products and services will grow – indeed soon it will dramatically eclipse domestic US markets. This will include ongoing growth in demand for products, as well as an explosion in demand for services, which is still a relatively modest

Various specific examples of these opportunities were cited. For instance, China has approximately 220 civil airports, compared to over 5,000 public civil airports in the USA (there are a further 14,000 private airports). Though China has invested heavily in high speed rail infrastructure (the US essentially has none), demand for air travel will continue to grow. This will translate into substantial demand for large commercial aircraft, creating significant opportunities for Airbus and Boeing, albeit in the face of strong competition from emerging domestic manufacturers.

American companies are well aware of these opportunities. As Rachel Duan, CEO of GE China commented: “We have to treat this as the new norm. Business goes where the growth is”. 

"We have to treat this as the new norm. Business goes where the growth is”.

Australian companies are on the ground building meaningful businesses in China too. Cochlear is building its first hearing implants manufacturing facility outside Australia in Chengdu, to service rapidly growing demand and build more direction connection with the Chinese market. As CEO Dig Howitt commented: “That market presence is important, there will be a small cost advantage that is important to us but that local presence and learning is a bigger factor”.

Meanwhile, like many countries, Australia has benefited from strong growth in inbound tourist visits from China and Hong Kong over the last decade. These reached a total of 1.7 million in the twelve months to April 2018, dwarfing arrives from near neighbor New Zealand, not to mention both of Europe and the Americas.

Trump can build walls and close borders, tax imports and shut down immigration and barely a ripple will hit China’s shores. 

So here’s the terrible truth for America: China’s economic growth and its future social prosperity is not much dependent on the USA. Trump can build walls and close borders, tax imports and shut down immigration and barely a ripple will hit China’s shores. Over the very short term, Trump’s trade war will impact trade flows in both directions, and result in the rerouting of a host of trade flows. But over the medium to long term, all this is likely to do is speed the decline of America’s importance to the world. As one Chinese senior speaker commented, “A trade war will never hinder China’s modernization”.

Put another way, China is simply playing a different game, with different rules, reflecting the political and economic reality of long term Asian growth. The APEC region is the single largest economic group in the world. China already exports far more to Asia than it does to the US, and this gap will only widen. Whether America comes to the party matters much to American interests, but not much at all to those in the East.

For almost every business outside China of any size, the opportunities are too important to overlook. There is much to be said for making small investments early, so that they can be leveraged by time and experience, rather than waiting until the prize is too large to be affordable. This may require a patient approach, but the prospective upside makes this well worthwhile. 

4. The Robot Revolution

This leads to another, much deeper point – and one that seems to be overlooked by many commentators in the USA. 

The technology revolution of the last fifty years, as well as the Robot Revolution now beginning to unfold, have been tremendously advantageous for the United States. As one example, the vast majority of global tech companies that have been built over last several decades are American. In Trump’s mind, MAGA may stand for “Make America Great Again”, but as every stockbroker knows, it also stands for Microsoft, Apple, Google and Amazon, the four largest listed companies in the US. 

These businesses embody globalisation, and also illustrate the extraordinary economic upside of international trade for companies with a highly scalable business model. America’s trade war against most of its traditional allies, and the abuse it continues to hurl at the political leaders of those countries, sends a loud message: “Diversify!”. Speaking at the forum, Canada’s Ambassador to China John McCallum made precisely this point. 

So, consider this: the impact of robotization on society is arguably the most fundamental problem facing most developed economies. Whilst some commentators suggest that new jobs will magically appear to replace those that are taken over by machines, the evidence of history directly contradicts this view. As a simple example, the last fifty years has seen almost no increase in real wages for most Americans, much as happened in the UK for fifty years in the nineteenth century. As a result, many countries will need to find new sources of revenues to address an increasing social welfare burden, and/or to fund economic stimulus to create new jobs. 

By attacking its allies, America makes it dramatically easier for those countries to impose mechanisms designed to capture more of the productivity benefits that America’s global companies have unlocked, by restructuring the way that they are taxed. Specifically, these companies generate substantial revenues but pay very little tax in many countries, due to operational structures designed to maximise what is generally legal tax avoidance. One simple solution to this is to impose sales taxes that are inversely linked to the number of jobs created – ie the fewer local individuals employed, the greater the sales taxes charged. For more on this subject, see our recent white paper, The Future of Society. 

There is also an important opportunity for progressive countries such as Australia, Canada and the UK to co-operate to attract more primary start-up activity, and to help more of the next wave of global, B2B tech start-up companies make those countries their home. If successful, this would ensure much greater participation in the economic value that these companies can create, and help to reduce the dramatic international wealth polarization that has occurred over the last twenty years. To put this comment in perspective, remember that the FTSE100 index is only modestly above its pre tech wreck peak, whereas US markets have more than doubled. 

China’s next wave of development also has a strong focus on the importance of technology and innovation. This includes a much greater emphasis on IP protection – both for domestic organisations, as well as for those from offshore that want to increase their operations in China. These developments are important, enabling world-leaders such as Cochlear to build substantial businesses in China.  

...an anti-competitive approach, designed to protect domestic manufacturers, will ultimately weaken leading US companies, making them less competitive

In contrast, an anti-competitive approach, designed to protect domestic manufacturers, will ultimately weaken leading US companies, making them less competitive. It’s hard to see how that will end well for those companies, or their employees or shareholders.

So, sacrilegious though this may seem, the global superiority of America’s tech ecosystem is under threat, and investment into the Chinese start-up sector exceeded US investment, partly as a result of massive support from the Chinese government. 

For those outside China, it is well worth your time to witness the energy, determination and creativity that this engenders first hand. Just as the speed and ambition of the entrepreneurial scene in most countries pales into insignificance compared to Silicon Valley and New York, some of the startups in China make their American peers look almost complacent. 

5. Financial Armageddon?

The American economy is financially stressed in several dimensions. At the simplest level, gross debt to GDP is fast approaching the all-time peak that resulted from the Second World War, and recent tax cuts may well drive it materially higher, particularly if an economic downturn ensues. Remember that the US is now a decade into an expansionary cycle, and there are plenty of economic clouds gathering on the horizon. Meanwhile, the country’s credit rating has started to slide. This reduces the capacity of government to adapt to changing circumstances, and in turn increases the perceived risks of America as a counterparty, albeit in a marginal way for now. 

Second, current fiscal settings are extremely loose – Trump’s tax cuts are forecast to add massively to national debt in the short term, and it is far from clear that these will stimulate sufficient economic growth rapidly enough to eventually offset these challenges over the longer term. Indeed, the tax cuts are concentrated almost entirely on the top few percent of society, where the propensity to spend increased income is lowest. Thus, current fiscal settings do not address the downward pressure on domestic earnings of depressed export markets – ideally the stimulus would be directed towards middle and low income earners, where the propensity to spend additional income is highest. 

Third, real increases in median incomes remain elusive – recent improvements simply return earnings levels to where they were in the year 2000. And, in judging these results, it’s critical to remember that social welfare provision is weak in many States in the USA, meaning that consumers have to pay for more or less everything out of their pay cheque. America’s public education system is patchy at best, and access to decent quality healthcare is almost entirely restricted to those that can afford to pay exorbitant health insurance premiums. Unemployment benefits are low. All of this translates into increasing wealth polarization, sowing the seeds of increased social unrest, and increasing the risk of radical political leaders emerging who make the case for a new social compact funded by dramatically increased taxes on the top 1%. 

It takes longer to travel the 17 miles from downtown New York to JFK Airport by public transport than the 67 minutes Japan’s new Maglev will take to make the 275-mile journey from Tokyo and Osaka

Fourth, most States are highly constrained in their ability to renovate the country’s aging physical infrastructure. This is, and will remain, a notable limiting factor on domestic US growth and a drag on quality of life. As one example, China has been able to build a comprehensive high-speed rail network connecting much of the country over the last two decades. To date, America has no high-speed rail at all, though a project to connect Dallas and Houston continues to progress slowly. This simply makes inter-city travel much slower and materially more expensive than it needs to be. To put this in context, it takes longer to travel the 17 miles from downtown New York to JFK Airport by public transport than the 67 minutes Japan’s new Maglev will take to make the 275-mile journey from Tokyo and Osaka. 

Fifth, unlike any other developed nation, US life expectancy has recently flat-lined. Whether this is a quirk of demographics, or an appalling enditement of the US healthcare system, remains subject to debate. But the harsh reality for the average American remains – live long and prosper is increasingly an American dream, whereas it is now a Chinese reality.

None of these factors, by themselves, are a death knell for American prosperity

None of these factors, by themselves, are a death knell for American prosperity. But, taken together, they underline significant headwinds that lie ahead for the US. We do not think closed borders and protectionism are an effective answer. The mood of the forum reflected this – though America is ultimately not of fundamental importance to the longer term economic outlook for the APEC region in general or China in particular, our sense is that most business leaders feel a little sadness that America appears determined to walk away from a mutually beneficial opportunity. 

All this being said, international financial tensions may be building. Remember that the global financial crisis was triggered by a failure of a series of large US financial institutions, as a result of a breakdown in effective prudential regulation. In plain English, too many large institutions were allowed to take on too much financial leverage, creating huge upside (and bonuses) for senior management, and massive economic pain for shareholders. Domestically, shares of companies like Citibank are still 90% below their all-time highs. 

And there have been significant international ramifications too. Net exporters – including China, Germany and Japan, have been significant investors in US government bonds. The US deployed quantitative easing as the primary policy response to the financial crisis, thus shifting the burden of paying for the crisis to those countries (through the impact on the US dollar). In short, reduced dependency on America is arguable attractive to many countries.

Wherever your organisation is based, the message is simple. Be cautious in assuming that the markets you know best represent the best combination of risk and reward as you seek to expand and diversify your business. The right small bets placed in China may dwarf what you can achieve domestically over a ten-year time horizon. Meanwhile, with dysfunctional political leadership, home markets can turn treacherous overnight, as both the USA and UK have demonstrated. In the words of the Bob Dylan song, Times They Are A Changin’.

The Day The War Began

So, to conclude, economic shifts of this magnitude happen only once a century or so. Just as Britain’s ascendancy ran its course, so too is America’s global economic leadership coming to an end. Trying desperately to preserve the status quo, and ignore the new forces at work, is a losing strategy, whether you are a country, a company, or an individual trying to help your kids figure out what to study at college.

Trying desperately to preserve the status quo, and ignore the new forces at work, is a losing strategy, whether you are a country, a company, or an individual trying to help your kids figure out what to study at college

The events of the last week will go down in history as marking a previously unthinkable and profound turning point in world economic history, with the world’s leading economic power launching a multi-front trade war that appears to target the very essence of its own century-long success. For those that set their strategy with a focus first on the long term, the upside is spectacular. As one presenter commented: “Today is a good day. Yesterday the trade war began, so all of the speeches we have prepared are void.” 

In other words, today is a day of new opportunity. America has declared trade war on a substantial proportion of the entire world. But though Trump may have chosen the low road, there’s no reason or need to follow. Other trade routes are open, and indeed offer much higher long-term growth potential.

All is not perfect in China, of course. Indeed, one of the country’s most tricky challenges is the cultural instinct to shy away from self-criticism, at least until a solution to the problem in question has been found. Nevertheless, the progress over the last five years has been dramatic, including an explosion in entrepreneurial activity, and the inherent unruly inventiveness and desire to challenge the status quo that this entails. Indeed, the populist opposition to globalization has grown in numerous countries because too many people were left behind. Ironically, this has been China’s success. 

Canada’s Ambassador to China John McCallum remarked that his specific mission was to support his countries desire “to do a great deal more with China”. When asked by his Chinese counterparts earlier this year what they should do to help increase collaboration, his advice was that it was important for the country to “match the eloquent words with corresponding strong actions.” 

Our advice to our clients is pretty much identical.  Don’t just sit back, talk about China, and look on with interest, because spectators never win the game. Follow China’s example, as it has followed the example set by the USA and the UK before it. Invest for international growth, experiment, adapt, learn and repeat. 

We’re following exactly this strategy ourselves, and it is already paying dividends. We’d be delighted to help you to do the same.

Nigel Lake is the co-founder and Executive Chairman of Pottinger, and co-founder and CEO of Atomli Inc. Follow him on Twitter @Nigel_Lake